Real estate downturn's impacts to linger for years

Commercial property owners

WASHINGTON — The repercussions of the biggest economic downturn since the Great Depression continue to ripple through multifamily and commercial property markets, and real estate agents and brokers helping their clients manage their investments need to stay on top of economic, regulatory, and legislative issues affecting lending, tax policy, health care and energy.

Charles Achilles, chief legislative and research officer for the Institute of Real Estate Management, summarized a dizzying array of issues facing commercial property investors, many of which will also have an impact on residential housing markets.

For multifamily and commercial property owners, loans remain hard to come by, Achilles said Friday, speaking at the National Association of Realtors’ midyear conference.

Debt and taxes

The nation’s growing debt, changes to the federal tax system, and implementation of health care reform also have implications for commercial property investors, Achilles said.

Declining property tax and other revenues have 35 states projecting budget shortfalls totaling $82 billion in 2012, Achilles said, and could produce "hundreds" of bankruptcies at the municipal level in the next 12 to 18 months.

Last year’s health care reform bill could put additional stress on state budgets, because it increases the scope of Medicaid coverage without providing revenue beyond 2016.

A number of states have sued the federal government, with mixed results, meaning the U.S. Supreme Court will probably have to weigh in on the issue, possibly by the end of the year.

The bottom line for commercial brokers and their clients is that in areas where state and local governments are struggling, tax increases may be inevitable and the potential for economic growth is reduced.

"You have to ask yourself, ‘Where are the jobs? Are there jobs where my portfolio is located?’ " Achilles said.

The federal deficit, which grew from 33 percent of gross domestic product in 2001 to 62 percent in 2010, could ultimately raise the cost of borrowing and curb economic growth, Achilles said.

A recent report by a bipartisan deficit reduction commission, the National Commission on Fiscal Responsibility and Reform, projects that by 2025, federal tax revenue will only pay the interest on the national debt.

The commission recommended returning spending to 2008 levels by 2013, and eliminating hundreds of tax breaks that reduce tax revenue by more than $1 trillion a year.

Achilles said some of the commission’s recommendations — including reducing the number of income tax brackets from six to three, and eliminating the alternative minimum tax (AMT) — would be good for commercial property owners.

But other recommendations — including treating capital gains that are currently taxed at 15 percent as ordinary income, and eliminating itemized deductions other than the mortgage interest deduction (MID) (see related article) — could have negative implications for commercial property owners, he said.

"The only difference between death and taxes is death doesn’t get worse every time Congress meets," Achilles said, quoting Will Rogers.

The commission’s final report recommended that the mortgage interest deduction be changed to a 12 percent nonrefundable tax credit, with only the interest paid on debt of up to $500,000 on a principal residence eligible. Homeowners are currently allowed to claim an itemized deduction for interest paid on total mortgage debt of up to $1 million on both their principal and second homes.

Although the report was not adopted by the full commission, Achilles said "it has some legs" in Congress.

NAR strongly opposes any changes to the mortgage interest deduction, saying such changes could further depress home prices by up to 15 percent.

For now, Congress and the Obama administration have been leery of raising taxes, with President Obama signing into law December legislation that extended Bush-era tax breaks for two years.

Achilles said the extension "will have substantial impact on (commercial) properties you own or manage," because general partners in properties will continue to pay 15 percent tax on capital gains, instead of up to 35 percent if those gains were treated as personal income.

Tax breaks for carried interest — which serve as an incentive for general partners to invest in property maintenance — also remain in effect.

Lending issues

Many community banks that specialize in commercial lending have been forced to make write-downs that limit their ability to make new commercial mortgage loans.

That’s a problem for commercial property owners who need to refinance, Achilles said — about $1.4 trillion in commercial loans are set to mature in the next few years, and more than half of commercial properties with mortgages are underwater.

Cutbacks in small-business lending mean more businesses fail, worsening unemployment and putting downward pressure on commercial rents, placing still more pressure on community banks, he said.

Two regulatory issues could make the situation worse, Achilles said.

The Financial Accounting Standards Board (FASB) is considering changes to accounting rules governing how lease contracts are treated on company balance sheets.

Currently, he said, companies can treat lease payments as operating expenses. FASBE and the International Accounting Standards Board (IASB) are proposing that companies recognize their full liability for leases on their balance sheets.

If the proposal is adopted, Achilles said, it could create problems for commercial property owners because tenants may want to renegotiate long-term leases to reduce the space they occupy and their rents.

The resulting reduction in cash flow could reduce a property’s value, and make it more difficult for owners to refinance, he said.

Another regulatory issue facing commercial property owners is bank regulators’ inconsistent treatment of loan-term extensions, he said. Loan-term extensions can help property owners who are unable to refinance weather the downturn, preventing billions in losses and stabilizing commercial property markets.

Banks "need greater flexibility to roll over performing loans" than some bank examiners are willing to give them, Achilles said.

Pending legislation that could help provide more liquidity to commercial lenders includes HR 940, which would create regulatory oversight for lenders to finance commercial loans using covered bonds.

Covered bonds, which have been used in Europe for years, won’t replace mortgage-backed securities or the secondary mortgage market, Achilles said, but could provide another avenue for channeling investment into mortgage lending.

Many lawmakers like the concept, because lenders keep loans financed by covered bonds on their books, giving them "skin in the game." Parallel legislation has been introduced in the Senate, and Achilles said the bills have a shot at passage.

Another bill that could boost commercial property markets, S 509, would raise the cap on credit union business loans from 12.25 percent of total assets to 27.5 percent. The National Credit Union Administration Board would have to certify that credit unions exceeding the current cap were well-capitalized.

Environmental issues

On the environmental front, commercial property owners should take advantage of incentives to retrofit their buildings for greater efficiency, as energy use accounts for about one-third of the operating expenses for commercial buildings.

The Obama administration has proposed an initiative aimed at achieving $40 billion a year savings through energy conservation, but IREM has yet to weigh in on the proposal, as no legislation has been introduced yet.

In general, IREM supports greater energy self-sufficiency and voluntary incentives for conservation, but opposes mandatory programs like "cap and trade" policies on emissions.

The Environmental Protection Agency has extended its lead-paint rules governing renovation, repair and painting to multifamily properties, he noted, and may propose a rule governing exteriors of commercial buildings this year.

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